1 Contemporary Issues of Public Finance in TaiwanVance Kuang-Ta Lo Associate Professor Department of Public Finance National Chengchi University October 21, 2016

2 Outlines Part I: Part II: Part III:Global Economic Situation and Outlook Current Domestic Economic Situation Part II: Taiwan’s Current Fiscal Challenges Part III: Why Do We Need a Government? Examples Remedies

3 Part I

4 Global Economic Situation and OutlookThis part was prepared by the Department of Economic Development of the National Development Council (NDC), TAIWAN’S ECONOMIC SITUATION AND OUTLOOK, Quarterly updates can be found on the NDC’s website at

5 Global Growth Forecast Revised Down AgainWith weaker than expected advanced economies, tepid growth rates for emerging markets, plus geopolitical tensions, both IMF and Global Insight cut their forecasts for 2016 world real GDP growth rate again in recent month. Forecast for Real GDP Growth Rate World Economic Outlook Projections for 2016 from Global Insight unit：% % 3.4 (2016/1) 2015 2016f World 2.7 2.4 (2.4) Advanced Economies 2.1 1.5 (1.5) United States 2.6 1.5 (1.6) Eurozone 1.9 1.6 (1.5) Japan 0.6 0.6 (0.5) Emerging Markets 3.9 3.9 (3.9) Mainland China 6.9 6.6 (6.6) 3.5 3.2 (2016/4) 3.1 3.2 (2016/7) 2.8 (2016/1) 2.9 2.5 (2016/7) 2.6 2.4 (2016/9) 2.3 IMF IHS Global Insight Note： The values in parentheses represent the release month. Source：1. IMF, World Economic Outlook, 2. IHS Global Insight Inc., World Overview Note：The values in parentheses represent the forecast in August growth rate are from official statistics. Source：IHS Global Insight Inc., World Overview, Sep. 15, 2016 5

6 Growth Momentum Slows In the USUS real GDP increased at an annual rate of 1.1% in the second quarter of , lower than expected, mainly held back by contracting business investment. However, private consumption grew by a strong 4.4% from 1.6% in the previous quarter. On August 26th, Fed Chair Janet Yellen said that the case for an increase in the federal funds rate has strengthened in recent months, in light of recent strong job growth. However, the markets think a move is more likely after the presidential election in November. PMI Index % % Real GDP Growth Rate 54 53.2 52.6 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 5.0 4.0 2.3 2.0 2. 6 0.9 0.8 1.1 -1.2 52 50 49.4 48 46 quarter Q1 Q2 Q3 Q4 month year 2014 2015 2016 year Note：PMI is between 0%~100%. If higher than 50%, it means manufacturing is in the expansion phase. If lower than 50%, it means it is in the contraction phase. Source：ISM, Sep. 1, 2016 Source：U.S. Department of Commerce, Aug. 26, 2016 6

7 Eurozone Slows Down Eurozone real GDP increased by 0.3% quarter on quarter in Q2 of 2016, lower than 0.5% in the previous quarter. In addition, manufacturing PMI was down to 51.7% in August 2016, slowing for the second consecutive month, reflecting that the expansion of manufacturing sector has decelerated. Inflation in the Eurozone was 0.2% in August 2016, unchanged from July. The ECB faces pressure to adopt a stimulatory monetary policy amid weak inflation and uncertainty over the effects of Brexit and Euroscepticism. Real GDP Growth Rate % % PMI Index 54 0.7 0.6 0.6 53 0.5 52.8 52.0 0.5 0.4 0.4 0.4 0.4 52 0.3 51.5 0.3 51.7 51 0.2 0.1 50 month year quarter year 1 20 15 2 3 4 1 2 Note： PMI is between 0%~100%. If higher than 50%, it means manufacturing is in the expansion phase. If lower than 50%, it means it is in the contraction phase. 7 Source： EuroStat, Sep. 6, 2016 Source：Markit, Sep. 1, 2016

8 Japan’s Economy Remains WeakJapan’s real GDP increased at an annual rate of 0.7% in Q2, lower than the 2.1% in the previous one, mainly because exports contracted further and private capital expenditure remained weak. Manufacturing PMI rose to 49.5 in August 2016, contracting at a slower pace. Prime Minister Shinzo Abe announced a 28 trillion Yen stimulus package to boost the flagging economy in July 2016. CPI annual inflation rate was -0.4% in July 2016, staying negative for the fourth consecutive month, mainly due to the fall of international energy prices. % Manufacturing PMI CPI Annual Inflation % month year month year 2016 Note： PMI is between 0%~100%. If higher than 50%, it means manufacturing is in the expansion phase. If lower than 50%, it means it is in the contraction phase. Source：Markit, Sep. 1, 2016 Note：Core CPI less fresh food. Source：Statistics Bureau of Ministry of Internal Affairs and Communications, Aug. 26, 2016 8

9 Mainland China’s Economy Shows Signs of StabilizationMainland China’s second-quarter GDP growth rate was 6.7% in year-over-year (yoy) terms, stronger than expected. Total trade and retail sales growth picked up pace in August 2016, while fixed asset investment growth for the year to August was unchanged from July, showing that China’s economy improved over the month. According to an IMF report released on August 12th, the country’s reliance on credit growth, in particular, clouds the country’s outlook. Without reforms, growth will stay high in the near term, but will likely weaken even more in the medium term and with a higher likelihood of a sharp slowdown. Growth Rate of Main Economic Indicators (% change, year-over-year) Retail Sales % 8.0 Real GDP Growth Rate 7.0 6.9 (YoY) 6.8 6.7 Q1 Q2 Q3 Q4 2015 2016 7.5 Fixed Asset Investment 7.0 6.5 Total Trade 6.0 Source：National Bureau of Statistics in Mainland China, Jul. 15, 2016 Source：National Bureau of Statistics in Mainland China, Aug. 12, 2016 9

10 Current Domestic Economic Situation

11 Foreign Trade Momentum Increases SlightlyTotal exports increased by 1.0% year-on-year in August 2016, mainly due to the strong demand for semiconductors, while Taiwan’s semiconductor manufacturing has benefited from its advanced technology and the rising global demand for mobile devices. Imports fell by 0.8% on a year earlier, with mineral products the main contributors to the decrease. Exports for the January through August 2016 period were down 6.6% on the same period a year ago. The Gross Value and Growth Rate of Exports and Imports US$, billion yoy, % 60 50 30 20 Gross value of exports (left scale) Gross value of imports (left scale) Export growth (right scale) Import growth (right scale) 40 10 1.0 30 -0.8 20 -10 10 -20 -30 2016 Note: Since FY2016, the general trade system is applied for compilation of external trade statistics and the historical data has been revised to FY2001. Source: Ministry of Finance, Sep. 2016 11

12 Industrial Production Declines SlightlyThe Industrial Production Index (IPI) posted an annual decrease of 0.31% in July 2016, mainly due to fact that building construction had a higher base period in July 2015 as a result of several major construction projects obtaining Building Use Permits during that period. Manufacturing output, which makes up more than 90% of the IPI, rose by % year-on-year in July. The increase in manufacturing output came largely from increased production of electronic parts and components, and chemical material. The Growth Rate of the Industrial Production Index y/y, % 20 10 -0.31 -10 -20 4 2014 7 10 1 4 2015 7 10 1 4 201 6 7 2013 Source: Ministry of Economic Affairs, Aug. 2016 12

13 Retail Trade Solid In July 2016, wholesale trade decreased by 1.5%, as global conditions remained weak. Retail trade rose by 2.8%, driven mostly by stronger general merchandise store sales as demand increased during the Ghost Festival and hot weather in July. Food and beverage services increased by 3.7% in July 2016. y/y, % The Growth Rate of Wholesale, Retail Trade, and Food Service 15 10 Wholesale Trade Retail Trade Food and Beverage Services - 2 3 4 5 6 7 8 9 10 11 12 1 2015 2016 3.7 5 2.8 1.5 -5 -10 -15 Source: Ministry of Economic Affairs, Aug. 2016 13

14 Employment Remains SteadyThe unemployment rate rose from 3.92% in June to 4.02% in July The seasonally adjusted unemployment rate held steady at 3.96%. The labor force participation rate rose from 58.68% in June to 58.84% in July, up 0.10 percentage points compared with a year earlier. Unemployment Rate and Labor Force Participation Rate % % 59.0 6.0 5.5 5.0 4.5 58.84 58.5 58.0 4.02 4.0 Labor force participation rate (left scale) 57.5 57.0 56.5 56.0 3.5 Unemployment rate (right scale) 3.0 2016 Source: DGBAS, Aug. 2016 14

15 Prices Up Slightly Taiwan’s CPI in August 2016 moved up 0.57% compared with the same month last year, mainly due to the 23.02% increase in the fruit index. In addition, prices of fish and seafood also went up 5.33%, and prices of food eaten outside the home increased 1.31%. Core prices (excluding fruit, vegetable and energy prices) increased by 0.77%. The WPI decreased by 4.10% year-on-year, due to prices of petroleum and coal products dropping 15.57%, and prices of crude petroleum and natural gas going down 13.41% y/y, % CPI and WPI inflation 4 0.57 -4 -4.10 CPI WPI -8 -12 2013 2014 Source: DGBAS, Sep. 2016 15

16 Monitoring Indicators Showing “Green” SignalIn July 2016, the trend-adjusted leading index increased by 0.63% to , and the trend-adjusted coincident index was up by 1.04% to The total score of the monitoring indicators in July 2016 increased by three points to 23, flashing the “Green” signal for the first month. Taiwan Business Indicators showed some scattered signs of economic improvement. Trend-adjusted Leading and Coincident Index Monitoring Indicators 104 Coincident Index 2016/7 101.77 100 Leading Index 2016/7 100.14 96 7 2014 10 1 4 7 10 201 6 1 4 7 2015 Source: NDC, Aug. 2016 16

17 Part II

18 Taiwan’s Current Fiscal Challenges

19 Our Current Fiscal SituationFrom 2008 to 2014, the annual expenditure is usually greater than the annual revenue, and the budget fiscal deficit of was US$ 7.1 billion. If we take the repayment of debt into consideration, the total fiscal deficit is US$ 9.2 billion, which should be balanced mainly by the issuance of debt.

20 However, the outstanding debt in Taiwan has shown an upward trendHowever, the outstanding debt in Taiwan has shown an upward trend. The ratio of outstanding debt to the average nominal GDP for the previous three fiscal years increased from 30.7% in 2008, 37.5% in 2013, and 38.1% in 2014, which is approaching to the legal debt ceiling of 40.6%. Therefore, it is quite difficult to balance our fiscal deficit by the issuance of debt. If the government does not adopt any reform measure, we may face fiscal difficulty in few years.

21 Gradual Increase in Statutory ExpenditureThe statutory expenditures have also shown an upward trend from 2008 to The overall figures also show that our expenditures are quite rigid and inflexible.

22 Increase in Expenditures due to Change in Major PoliciesMoreover, the structure of the population is changing. For example, a low fertility and an aging population are having an impact on related policies. In addition, we are planning to implement the major policies of “12-Year National Fundamental Education” and “Long-Term Care” among others. And, thus, we expect that the related expenditures will be on the increase. Impact of a low fertility and aging population on major policies Plans to implement major policies of “12-Year National Fundamental Education” and “Long-Term Care,” etc. Increase in related expenditures

23 Revenue Structure and Tax Burden RatioAs for our revenue structure, tax revenue composes the main part of the revenues. The ratio of tax revenue to total revenues was 70.4﹪in However, our tax burden ratio was only 12.6% in the same year. This means that there is still room for raising tax revenue. Revenue Structure Tax Burden Ratio

24 Remarks (1/5) We think there are three main challenges to Taiwan’s fiscal account, which lead to concern over continued fiscal deficits and rising government debt level. (1) Sub-trend GDP growth With its high export dependency, Taiwan’s economic growth is negatively affected since the onset of the global credit crisis in 2008. Weakened consumption demand in the developed markets have been negatively affecting Taiwan’s export sector and the overall economy.

25 Remarks (2/5) The growth slowdown has impacted the fiscal accounts in two ways: First, it has slowed the growth in fiscal revenue. Taiwan’s general government net revenue growth has slowed to 0.8% per year from 2008 to now, compared to 3.8% per year from 2004 to 2007. Second, it has expedited the growth in fiscal expenditure. Because of the slowdown in growth, the government has to allocate more spending on infrastructure projects to boost the economy. As a result, net general government expenditure growth has accelerated to 3.5% per year between 2008 and now, up from 0.9% per year between 2004 and 2007.

26 (2) Low tax burden Remarks (3/5)Taiwan’s tax revenue represented only about 12.2% of GDP in 2012, which is much lower than other countries.

27 Remarks (4/5) (3) An aging populationAn aging population is the most serious challenge to Taiwan’s fiscal condition in the coming years. According to the Council for Economic Planning and Development (CEPD), Taiwan’s population is expected to rapidly age starting from 2013 onwards. The percentage of old-age population (defined as age 65 and above) is expected to rise from 11.5% of the total population in 2013 to 14.6% in 2018, and continue rising in subsequent years. At the same time, the working-age population (defined as age 15 to 64), is expected to shrink from 74% of total population in 2013 to 72.7% in 2018. The old-age dependency ratio is hence expected to drop from around 6.4 in 2013 to 4.9 in 2018, and continue deteriorating.

28 Remarks (5/5) The aging of Taiwan’s population is structural, which makes it very difficult to alter by the government over the medium term. This should have serious implications on the government’s tax revenue, and more importantly, on the government’s social security and pension-related spending. In 2011, social security and pension expenditure represented 5.5% of GDP and 28.7% of the general government net expenditure. The ratios are projected to rise further to over 7% of GDP and 33% of government expenditure in 2018 as the population ages, assuming no effective reform measures are introduced to avert the trend.

29 ＞ 7% : Aging the percentage of elders over 65 years old 14%: AgedBased on the definition from World Health Organization (WHO): 7% : Aging 14%: Aged 20%: Super-Aged the percentage of elders over 65 years old ＞

30 Total, % of population, 2014

31 According to Figure 8, the share of Aged 65 and above has an upward trend during 1980 to 2060.Taiwan has been considered as an aging country since 1993. Taiwan is further forecast to become an aged society and super-aged society in 2018 and 2025, respectively. As pointed out by Hsueh and Wang (2008), the aging rates will grow faster in Taiwan than in most of the developed regions in the future. It will take only 25 years for the aged portion of the Taiwan population to rise from 7% to 14%, second only to Japan (taking only 24 years) in terms of the shortest time span.

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33 Taiwan’s population aging is the result of low death rate due to advance medical technology, low birth rate, and prolonged life expectancy. Figure 9 shows the life expectancy of all Taiwanese, male and female people.

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35 Significant Decline in FertilityFigure 10 presents a time trend of general fertility rate (GFR, hereafter) and total fertility rate (TFR, hereafter) of Taiwan during TFR has been lower than replacement level of 2.1 since 1985. In 1985, the TFR was It was even lower than 1 in 2010, only

36 General fertility rate (GFR) Total fertility rate (TFR)the number of births in a year divided by the number of women aged 15–44, times It focuses on the potential mothers only, and takes the age distribution into account. Total fertility rate (TFR) the total number of children a woman would bear during her lifetime if she were to experience the prevailing age-specific fertility rates of women. TFR equals the sum for all age groups of 5 times each ASFR rate. Age Specific Fertility Rate (ASFR) = (Number of births to women in age group i / Number of women in age group i) x 1000 Reference: Wiki, https://en.wikipedia.org/wiki/Fertility Let B = Number of birth Let W = Number of women of reproductive ages Total Fertility Rate (TFR) = (The sum of the ASFR x The number of years in each age group) / 1000

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38 Interestingly, the fluctuations of both fertility rates shown in Figures 3 follow Taiwanese people’s preference of some peculiarly Chinese characteristics. For example, Dragon is most auspicious, but Tiger is most stigmatized. Snake is also less auspicious. Therefore, every Taiwanese parent is hoping to have a Dragon baby, but not a Tiger baby.

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40 Rat Ox Tiger Positive aspects: Intelligent, Charming and ConfidentNegative Aspects: Jealous, Selfish, Ruthless Positive aspects: Hardworking, Loyal, Patient, Good Hearted Negative Aspects: Critical, Petty and Vain Positive aspects: Independent, Productive and Loyal Negative Aspects: Stubborn, Anxious and Moody

41 Rabbit Dragon Snake Positive aspects: Intelligent, Charming and Confident Negative Aspects: Jealous, Selfish, Ruthless Positive aspects: Hardworking, Loyal, Patient, Good Hearted Negative Aspects: Critical, Petty and Vain Positive aspects: Well- mannered, caring and sensible Negative Aspects: Insecure, Pessimistic and Sly

42 Horse Sheep Monkey Positive aspects: Independent, Productive and LoyalNegative Aspects: Stubborn, Anxious and Moody Positive aspects: Well- mannered, caring and sensible Negative Aspects: Insecure, Pessimistic and Sly Positive aspects: Intelligent, Charming and Confident Negative Aspects: Jealous, Selfish, Ruthless

43 Rooster Dog Pig Positive aspects: Hardworking, Loyal, Patient, Good Hearted Negative Aspects: Critical, Petty and Vain Positive aspects: Independent, Productive and Loyal Negative Aspects: Stubborn, Anxious and Moody Positive aspects: Well- mannered, caring and sensible Negative Aspects: Insecure, Pessimistic and Sly

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45 Part III

46 Why should the government have to intervene the market?Something wrong in the market, or something special in the market (so called market failure) Examples Public goods Externality Others

47 Private Goods ： A good whose consumption by one consumer prevents simultaneous consumption by other consumers. ：A good for which it is possible or very easy to prevent consumers who have not paid for it from consuming it. Ex：

48 Public Goods ：A good may be consumed by many individuals at the same time at no additional cost. ：A good for which one cannot at low cost, or even impossible, prevent those who have not paid for the good from consuming it. Ex：

49 Why do public goods result in the market failure?Non-rival ＋ non-excludable The fundamental problem with non-rival and non-excludable goods is that someone has to pay for the good’s production, but can be excluded from consuming the good once it is produced. The incentive for the individual is to let produce the good and then use it once it is available for free. This is known as the : individuals have little incentive to pay for their own consumption and instead will take a “free-ride" on anyone who does pay. As a result, non-excludable goods tend to be

50 Externality An externality occurs whenever the actions of one party make another party worse or better off, yet the first party neither bears the costs nor receives the benefits of doing so. In other words, an externality is the situation in which an action by an individual producer or consumer affects other parties (in a good or bad way), without payment or compensation for the cost or benefit affecting them.

51 Examples: I am smoking at a restaurant.I am listening to some nice music around you. A farmer who grows apple trees provides a benefit to a beekeeper. The beekeeper gets a good source of nectar to help make more honey.

52 Why do externalities result in the market failure?

53 What can the government do?Intervene the market directly, say price control, regulation, tax… Some new ideas: The example of public goods The example of externality

54 How to Catch the Thief?  How to let people report their true preferences for a public good?  How to share the cost of a public good based on individuals’ true preferences? Mom lost her $10, either Alex or David stole the money. If Alex really stole $6, and David stole $4. How does Mom know？

55 Preference Revelation MechanismMechanism A：  If you said you stole $1, you will be punished by 1 hand-beating with a ruler.  Result? Mechanism B：  10－(the other person’s report)

56 How to Let Alex Truly Report?Report honestly  10－(David’s possible reports) David reports $0 → $1 → $2 → $3 → $4 → $5 →

57 Coase Theorem If the transaction (or bargaining) costs are negligible and the numbers of parties are few, an efficient solution to an externality is achieved as long as someone is assigned property rights, of who is assigned the rights. In other words, we need a buyer and a seller; that is, we need a “ ”.

58 A market is composed of buyers and sellers:1. Smokers have to pay non-smokers for smoking  Non-smokers have the right of clean air  Non-smokers (sellers/owner); smokers (buyers) 2. Non-smokers have to pay smokers for not smoking  Smokers have the right of smoking  Smokers (sellers/owner); non-smokers (buyers)

59 But, who should have the rights? (married or divorced?)

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61 If Brad has the rights (seller):Brad (seller) will ask Angelina (buyer) at least to pay him $20. Angelina (buyer) is willing to pay Brad at most $50. 　 Brad will say YES! They will get divorced! and more importantly, Divorced ＝Social optimality

62 If Angelina has the rights (seller):Angelina (seller) will ask Brad (buyer) at least to pay her $50. Brad (buyer) is willing to pay Angelina at most $20. 　 Brad cannot afford it. They will get divorced! and more importantly, Divorced ＝Social optimality

63 Interesting Remarks：  Who has the property rights does not matter, the thing is whether or not we have the  We just care about whether or not we can have a to help us.

64 Problems on “Coase Theorem”:Too many parties are involved. Higher negotiation costs. We do not know who makes pollution. Each party does not have the same power to negotiate. Applications: The EU Emissions Trading System (EU ETS)

65 Thank you